For Spain, borrowing cost relief may prove temporary

Spain’s 10-year borrowing costs fell to their lowest level since January in an auction on Thursday, although the relief from market pressure may be short lived as Prime Minister Mariano Rajoy hesitates over seeking an international bailout.

The yield on the benchmark 2022 bond fell to 5.666 per cent with almost three times more offered than the amount sold. Demand was also strong for a three-year bond. The Treasury sold a total of €4.8 billion in the bonds, above its target.

Investors have been encouraged by the European Central Bank’s decision to buy the debt of troubled governments such as Spain’s, provided they first request help from the euro zone’s rescue funds. Such a bailout may bring demands for more unpopular austerity, and Rajoy has repeatedly said he is studying an aid request but does not want Europe to dictate conditions.

Markets expect that Rajoy will be pushed into a request sooner rather than later, as borrowing costs may start rising again if the ECB purchases fail to materialise.

“The relaxation of the markets is temporary, and if investors start thinking Spain is moving away from a rescue, that would be negative," said Soledad Pellon of IG Markets in Madrid.

Spain is at the heart of the euro zone debt crisis, now in its third year, with investors worried it will not be able to bring down its public deficit and control its debt due to a recession.

The bulk of the debt sold, or €3.9 billion, was in the shorter-dated bond, which was in high demand because it would be eligible for purchase by the ECB if Spain asks for a rescue, indicating markets are betting on Spain getting aid. Market reaction was muted after Thursday’s auction.

The spread between yields on Spanish and Germany benchmark bonds , which is a measure of the perceived risk of investing in Spain, widened from Wednesday’s close to 427 basis points. This was still way off a July peak of well over 600 basis points.

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The yield on Spain’s ten-year bond on the secondary market was up around 8 basis points on the day at 5.8 per cent, some way down from a peak over 7.5 per cent hit in July.

With many of Spain’s 17 regions unable to meet debt payments this year, the central government is stepping in and bailing them out to the tune of €18 billion, putting further tension on finances.

Frustration over taxes and separatist sentiment are growing in cash-strapped Catalonia, a powerful northeastern region that generates a fifth of Spain’s economic output, has its own language and is largely self-governing. The leader of Catalonia’s regional government, Artur Mas, hinted on Thursday at holding early elections after his call for grater tax autonomy was rejected by Rajoy in a meeting between the two in Madrid.

RESCUE WOULD HELP CREDIT RATING

As well as reassuring investors Spain could meet its debt repayments, a bailout would mean more rigorous control of its budget after it consistently missed deficit targets in recent years, analysts say.

Spain’s credit is rated one notch above junk grade by the Moody’s agency, which is due to complete a review of Spain by the end of the month. Rival Standard & Poor’s said on Wednesday it was unlikely to cut Spain’s rating below investment grade in the near future given the lifeline promised by the ECB’s new bond-buying programme.

Spain has now raised 82 per cent of its planned medium- and long-term borrowing for this year. However, it faces a refinancing hump of €27.5 billion in October and will need to raise an additional €10 billions to compensate for falling revenues and soaring unemployment and pensions payments. It has increasingly depended on domestic banks to buy its debt at auctions. That reliance would be reduced if it sought a rescue package.

Spain has already requested €100 billion of aid for its banks, crippled when a property bubble burst. Rajoy’s government has committed to austerity measures worth 10 per cent of gross domestic product up to the end of 2014 and believes more would lead to a public backlash.

But a fresh jump in yields, more calls for cash from indebted regional governments or problems hitting this year’s EU-agreed deficit targets could all push Spain into seeking ECB and European aid despite its hesitancy over the conditions.

“The funding costs have come down significantly, almost 1 per centage point on the 10-year, so it’s another hurdle the Treasury has overcome. Still, markets expect Spain will request a rescue package at some point," said Luca Cazzulani, deputy head of fixed income at UniCredit.

ECB Governing Council member Luc Coene warned Rajoy on Monday not to delay triggering the programme, which would involve requesting aid from the euro zone’s new ESM bailout fund, and risk another rapid rise in yields.